We model the choice of lease type, gross lease versus net lease, in an environment in which lessees have private information with respect to their expected intensity of utilization of the leased space, and in which lessors have market power with respect to the pricing of the lease. Unless the lessor can provide operating services at lower cost than the lessee, there exists a lemons problem. We examine a market in which lessors can provide operating services at lower cost. Given asymmetric information with respect to expected lessee utilization and/or damage to the leased space, the lessor offers both a gross and net lease, where the higher expected utilization lessees select the gross lease and the lower expected utilization lessees select a net lease. Lease pricing depends on both the lessors beliefs with respect to lessee utilization of the space and the lessor's market power. In a monopolistic market, relative to a competitive market, a lessor charges higher rent for a gross lease relative to a net lease i n order to extract a portion of the gain from shifting operating services to the lessor. Given the higher rent for a gross lease, a smaller proportion of lessees (only very high utilization lessees) selects a gross lease in a monopolistic market. Therefore, the expected cost savings associated with shifting operating services/provision of maintenance to the lessor are smallest in a monopolistic market.

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Real estate leasing is a contractual arrangement between an owner and a user of property, which specifies the periodic rent, the term and numerous provision clauses including provision for operating management and maintenance services. An important issue in leasing is the lessee's potential usage of the property, which is the lessee's private information. Given asymmetric information with respect to the lessee's expected intensity of property utilization, this paper examines the choice between a gross lease and net lease. In general, a gross lease is one in which the lessor pays all operating expenses including utility expenses, property taxes, maintenance, and repair. In contrast, with a net lease, the lessee pays some or all of the operating expenses. In real estate leasing practice, net and gross leases are both widely utilized, although usage varies across types of properties. Net leases are almost exclusively observed for industrial and agricultural properties, while gross leases are more popular in shop ping center leasing. Both net and gross leases, however, are employed in office space leasing. These observations raise an important question: What determines lessor and lessee choice between a gross lease and a net lease? For lessors, the question is even more intriguing. How can lessors structure and price the gross lease if they cannot determine ex ante a lessee's potential usage of the premises and services?

It is often argued that there are economies of scale associated with lessor provision of operating management and services and that lessors can provide management and maintenance services at lower cost than lessees. Lessor provision of services also mitigates contracting problems and reduces negative externalities among tenants of multitenant retail properties. Recently, however, the retail industry has become more convenience oriented and the retail format has gradually changed to favor freestanding buildings for tenants such as large department stores, bookstores, and specialty stores. The "big-box" type of detached buildings leased to a single tenant retailer are often structured as double or triple net leases (Mattson-Teig 2000). In the office leasing market, where, traditionally, gross leases prevail because most office buildings have had multiple tenants, the use of net leases has also increased. In particular, beginning in the 1990s, corporations have gradually recognized the advantages of pushing real estate off their balance sheets and effectively "debt financing" 100% of these assets. …

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